Being a Director comes with responsibilities

Everyone loves a title. Whether it’s self-aggrandisement, public recognition of good work done, or as a function of a role, titles are everywhere. But while some titles are honorific, others, such as that of company director, carry duties and obligations that are backed by legal sanction. And for good reason too.

Sadly, for the motor trade, it’s not hard to find examples of directors getting into trouble.

Being a Director brings great responsibility (DALL-E2, Generative)

Back in 2017, the Lancashire Post reported that the owners of a Preston garage that misled customers over their rights had been banned from being company directors for three years by a judge.

Mubasshar Azam and Amar Ahmed were directors of Rockbank Motors Ltd, which ran Peter Ashton Car Sales on Southgate, Preston, and Eccles Hill Motors, Darwen. They sold cars via paperwork headed ‘spares/repairs invoice’ which sought to indicate that vehicles were being sold as unroadworthy and as such any faults were the responsibility of the consumer. They also included a clause on invoices that any return of a vehicle would result in a restocking charge of £395. The actions were in contravention of 2012 trading standards advice. Along with being banned from being company directors they were given 200 hours unpaid work. Ahmed also received a curfew and Azam a rehabilitation activity requirement.

More recently the Eastern Daily Press noted in 2021 that Adam Hughes and Andrew Wood, directors of Concorde Tyre & Exhaust Centres Ltd, had been banned from running companies for a total of 25 years after they provided false documents to secure £176,000 of loans.

Between 2011 and 2017 the company expanded to nine sites. But this growth led to cash flow problems and administrators were appointed to undertake a pre-packaged sale of the business.

Administrators discovered a third party had petitioned the court to wind-up the company and had difficulties establishing who owned the company’s assets and who had secured loans against them. The company also supplied false documents to secure finance against assets Concorde did not own. Wood subsequently voluntary signed a 12-year disqualification and Hughes received a 13-year disqualification order.

So, with the background set, what exactly are the duties that the law places on directors?

 

Duties laid down

According to John Hamer, a partner at Walker Morris and head of corporate at the firm, the Companies Act 2006 sets out seven duties of a director. Before listing them, he says it’s important to note “that up until the 2006 Act was passed, there wasn’t a code of directors’ duties, instead they had to be gleaned from a mixture of case law and various pieces of legislation.” He adds that the rationale behind the codification of these directors’ duties was to make the law easier to understand, particularly for new directors.

Be sure you understand the legal consequences as a director (Pic: DALLE2, generative)

The statutory duties written into the Act are the duty to act within powers; to promote the success of the company; to exercise independent judgment; to exercise reasonable care, skill and diligence; to avoid conflicts of interest; not to accept benefits from third parties; and to declare any interest in a proposed transaction or arrangement with the company. (See panel 1).

Of course, when business is good, few tend to worry about their duties and obligations. But that isn’t the case when business turns sour.  As Hamer outlines, the duties owed by a director to a company change in the lead up to insolvency and “require directors to have proper regard for the interests of creditors. While it is clear that this rule comes in to play before the start of a formal insolvency process, precisely when it becomes relevant is less clear.” The issue at heart is that directors should be conscious of the provisions of the 2006 Act and also the Insolvency Act 1986. These pieces of legislation can make directors personally liable as a consequence of their actions during the period before and on insolvency. Typically, these include wrongful trading, fraudulent trading and misfeasance. As Hamer has regularly seen, “the consequences of these actions are draconian and so advice should be taken early on to make sure that directors don’t face personal liability.” It’s precisely for this reason that he also advises recording all decisions so that these notes can be relied on as evidence in any subsequent inquiry or legal proceedings: “Showing that you were acting reasonably in the circumstances at the time will largely protect you even though hindsight may show that the decisions you made turned out to be poor ones.”

The key point here is that when a company gets into financial difficulties a director must ensure that the company does not continue to take on credit in circumstances where there is no reasonable prospect of it being able to repay creditors. In addition, and this is particularly important says Hamer, “a director must seek to treat all creditors equally and not prefer any single particularly any creditor with whom directors or shareholders have some connection.” In other words, no sweetheart deals.

 

The state of the law

The problem with the law is that it can be a particularly blunt instrument, riddled with loopholes and open to interpretation. Indeed, it was Charles Dickens’ character, Mr Bumble who, in Oliver Twist, noted that “the law is an ass”.

Philip King, former chief executive of the Chartered Institute of Credit Management, considers the biggest risk to firms – and the reputations of directors – to be that of ‘phoenixism’ – where a firm fails only to be reborn, without the debt, often with the same managers and owners.  “The changes to pre-pack administrations, and the introduction of the Pre-Pack Pool following the Teresa Graham review have,” says King, “enhanced the level of transparency significantly.” That said, he says that engagement by creditors with insolvency practitioners and the insolvency process to be important, “as is the decision as to whether to trade with a business that has risen from the ashes of a customer from which a bad debt has been incurred.”

From a legal stance, Hamer’s thinks that company law strikes the right balance: “We have limited liability companies in order to promote entrepreneurialism and it is inevitable that some businesses will fail with the founders often having invested considerable sums and losing it all.” He continues: “Creditors can be pulled down by these failures but ultimately credit risk is a business risk which every supplier must manage. There are of course those people who ‘play’ the system and have multiple failures which they walk away from.”

 

Is there a saving grace?

The obvious question to ask is whether the actions – mistakes – of directors – are deliberate, inadvertent, or made through a genuine misunderstanding of the law (while trying to act honourably).

It should be recognised that some sleepwalk into directorships; that many holding a directorship will have worked hard for businesses and have been promoted into a position which the owners feel is a reflection of that individual’s efforts and loyalty over the years. 

With his lawyer’s hat on, Hamer suspects that most mistakes are inadvertent – “I don’t think there are many directors who deliberately breach their duties.” However, he does think that mistakes probably come about “through a lack of knowledge and understanding of their role as directors.” He also worries that inexperienced directors can sometimes be influenced by stronger and more experienced directors, as well as dominant shareholders, into making decisions that they are not wholly comfortable. In such circumstances the advice is crystal clear: “They should seek to get independent advice as to the lawfulness of their decisions or actions.”

King takes the view that directors should be taught their craft, noting: “There is no requirement for training before becoming a director or running a company and no requirement to demonstrate competence or suitability – so there are myriad ways in which mistakes can be, and are, made.” Even so, he nevertheless warns firms to remember who they’re trading with because “the only requirements to be a company director are that the individual must be 16 or over and not be disqualified from being a director.”

That said, it’s just as important to remember that while some directors are dishonest and set out to exploit suppliers, many are just ill-advised and/or ill-prepared for the challenges of running a business and make mistakes often unknowingly.

 

In the shadows

Another complication to deal with is what are termed ‘shadow directors’ – individuals acting as a director but without the formal title or registration at Companies House. Both King and Hamer see problems as shadow directorships are hard to prove and the opportunity for abuse of process at a distance is always a possibility.

‘Shadow directors’ (Pic: DALL-E2, generative)

Hamer knows of circumstances where, in particular, a dominant shareholder exerts influence as a shadow director and other directors are not sufficiently robust to fight their corner – even though the law expects a director to do so.

King, on the other hand, says – again – that to combat the problem “it’s important to know who is really pulling the strings and controlling the activities of the business.”

 

To end

As the old adage goes, Turnover is vanity, profit is sanity, but cash is reality. Problems do happen in business but for directors, not understanding or acting in accordance with the law can be very expensive. In the worst case, it can lead to an income-restricting directorship ban that can last 15 years as well as personal liability for company debts (see panel 3). And as a trawl of the web indicates, cases are brought, and directors are being disqualified.

Readers have been warned.

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